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Equity markets continued to grind higher in the second quarter despite continued tapering by the Federal Reserve, a negative GDP print, and rising geopolitical tensions. All asset classes have delivered positive returns in the first half of the year, led by long-term U.S. Treasury bonds. There has been a lack of volatility across all asset classes; the CBOE Volatility Index (VIX) fell to its lowest level since February 2007.

Year to date the U.S. equity markets are slightly ahead of international markets. All S&P sectors are positive year to date, led by utilities and energy. Mid cap value has been the best performing style, helped by the double-digit performance of REITs. U.S. large caps have outperformed small caps, but after experiencing a drop of more than -9%, small caps rebounded nicely in June. Value leads growth across all market capitalizations.

Despite concerns surrounding the impact of Fed tapering on emerging economies, emerging market equities outperformed developed markets in the second quarter, and have gained more than 6% so far this year, putting the asset class ahead of developed international equities. Small cap emerging markets and frontier markets have had even stronger performance. The dispersion of performance within emerging markets has been high, with India, Indonesia and Argentina among the top performers, and China, Mexico and Chile among the laggards. On the developed side, performance from Japan has been disappointing but a decent rebound in June bumped it into positive territory for the year-to-date period.

Despite a consensus call for higher interest rates in 2014, U.S. Treasury yields moved lower. The 10-year Treasury Note is currently trading at 2.6% (as of 7/7/14), still below the 3.0% level where it started the year. While sluggish economic growth and geopolitical risks could be keeping a ceiling on U.S. rates, technical factors are also to blame. The supply of Treasuries has been lower due to the decline in the budget deficit, and the Fed remains a large purchaser, even with tapering in effect. At the same time demand has increased from both institutions that need to rebalance back to fixed income after experiencing strong equity markets returns, and investors seeking relative value with extremely low interest rates in Japan and Europe.

With the decline in interest rates and investor risk appetite for credit still strong, the fixed income asset class has delivered solid returns so far this year. Both investment grade and high yield credit spreads continue to grind tighter. Emerging market bonds, both sovereign and corporate, have also experienced a nice rebound after a tough 2013. Municipal bonds benefited from a positive technical backdrop with strong demand for tax-free income being met with a lack of new issuance.

We approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds, with a number of factors supporting the economy and markets over the intermediate term.

Global monetary policy remains accommodative: Even with quantitative easing slated to end in the fall, U.S. short-term interest rates should remain near-zero until 2015 if inflation remains contained. The ECB and the Bank of Japan are continuing their monetary easing programs.

Global growth stable: We expect a rebound in U.S. growth in the second quarter after the polar vortex helped to contribute to a decline in economic output in the first quarter. Outside of the U.S., growth has not been very robust, but it is still positive.

Labor market progress: The recovery in the labor market has been slow, but we have continued to add jobs. The unemployment rate has fallen to 6.1%.

U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash. M&A deal activity has picked up this year. Corporate profits remain at high levels and margins have been resilient.

Less Drag from Washington: After serving as a major uncertainty over the last few years, Washington has done little damage so far this year. Fiscal drag will not have a major impact on growth in 2014, and the budget deficit has also declined significantly.

Risks facing the economy and markets remain, including:

Fed Tapering/Tightening: If the Fed continues at the current pace, quantitative easing will end in the fall. Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, this withdrawal is more gradual and the economy appears to be on more solid footing this time. Should inflation pick up, market participants will shift quickly to concern over the timing of the Fed’s first interest rate hike. Despite the recent uptick in the CPI, the core Personal Consumption Expenditure Price Index (PCE), the Fed’s preferred inflation measure, is up only +1.5% over the last 12 months.

Election Year: While we noted there has been some progress in Washington, we could see market volatility pick up later this year in response to the mid-term elections.

Geopolitical Risks: The events surrounding Iraq, as well as Russia/Ukraine are further evidence that geopolitical risks cannot be ignored.

Risk assets should continue to perform if we experience the expected pickup in economic growth; however, we could see increased volatility and a shallow correction as markets digest the end of the Federal Reserve’s quantitative easing program. Economic data, especially inflation data, will be watched closely for signs that could lead the Fed to tighten monetary policy earlier than expected. Equity market valuations look elevated, but not overly rich relative to history, and maybe even reasonable when considering the level of interest rates and inflation. Investor sentiment remains overly optimistic, but the market trend remains positive. In addition, credit conditions still provide a positive backdrop for the markets.

Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Asset Class

Outlook

Favored Sub-Asset Classes

U.S. Equity

+

Large cap bias, dividend growers

Intl Equity

+

Emerging and Frontier markets, small cap

Fixed Income

–

Global high yield credit, short duration

Absolute Return

+

Closed-end funds, event driven

Real Assets

+/-

MLPs, natural resources equities

Private Equity

+

Diversified

Source: Brinker Capital

Brinker Capital, Inc., a Registered Investment Advisor. Views expressed are for informational purposes only. Holdings subject to change. Not all asset classes referenced in this material may be represented in your portfolio. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. Past performance is not a guarantee of similar future results. An investor cannot invest directly in an index.

In January 2013 Amy Magnotta wrote in detail about how the actions of the European Central Bank (ECB) finally gave the markets confidence that policy makers could get their sovereign debt problems under control.[1] The purpose of this blog is to measure the progress of the ECB’s actions, as well as other critical steps taken to resolve the Eurozone crisis.

Maintaining the Euro: A+The markets put a lot of faith in the comments made by the head of the ECB Mario Draghi in July, 2012. Draghi stated that he would “Pledge to do whatever it takes to preserve the euro.” These words have proven to be monumental in preserving the euro as a currency. Following his announcement, the ECB still had to put together a plan that would be approved by the ECB’s governing council (comprised of banking representatives from each of the 18 EU countries)[2]. The politics of the approval essentially boiled down to whether or not each council member supported the euro as a currency. Draghi’s plan ultimately passed when Germany’s Chancellor, Angela Merkel, endorsed it in September 2012.[3] The stabilization of the euro boosted lending and borrowing for European banks, and allowed governments to introduce necessary economic reforms outlined in the plan.

Since the plan was approved, the euro’s value versus the U.S. Dollar has continued to rise; reaching levels last seen in 2011. There is still some debate as to whether or not the currency will last over the long term, but for now its stability has helped avoid the worst possible outcome (financial collapse). There are several key elections coming up over the next month, which could renew the threat of breaking up the currency if anti-EU officials are elected.

Government Deficit Levels: B
The average Eurozone government deficit came in at 3.0% in 2013, which was down from 3.7% in 2012. Budgets will need to remain tight for years to come.

Corporate Earnings: B
The MSCI Europe All Cap Index has returned 27.46% in 2013 and 5.01% so far in 2014 (as of last week). The Euro area also recorded first quarter 2014 GDP growth at +0.2% (-1.2% in Q1 2013).[4] This indicates that companies in Europe have established some positive earnings growth since the peak of the crisis. On a global scale, Europe looks like an attractive market for growth.

Unemployment: C
Unemployment in the Eurozone has stabilized, but has not improved significantly enough to overcome its structural problems. The best improvements have come out of Spain, Ireland and Portugal due to a variety of reasons. In Ireland, emigration has helped reduce jobless claims while a majority of economic sectors increased employment growth. In Spain, the increased competitiveness in the manufacturing sector has been a large contributor. Portugal has seen a broad reduction in unemployment stemming from the strict labor reforms mandated by the ECB in exchange for bailout packages. These reforms are increasing worker hours, cutting overtime payments, reducing holidays, and giving companies the ability to replace poorly performing employees.[5]

There are also some important fundamental factors detracting from the overall labor market recovery. The large divide between temporary workers and permanent workers in many Eurozone countries has made labor markets especially difficult to reform. This is likely due to a mismatch of skills between employers and workers. High employment taxes and conservative decision-making by local governments and corporations have also created challenges for the recovery.

Debt Levels: D
Total accumulated public debt in the Eurozone has actually gotten worse since the ECB’s plan was introduced. In 2013 it was 92.6% of gross domestic product, up from 90.7% in 2012. The stated European Union limit is 60%, which reflects the extremely high amount of government borrowing required to stabilize their economies.

Overall Recovery Progress: B-
On a positive note, governments are finally able to participate in bond markets without the fear of bankruptcy looming. Banks are lending again. Unemployment appears to have peaked and political officials recognize the importance of improving economic progress.

Unlike the 2008 U.S. recovery however, progress is noticeably slower. The social unrest, slow decision making, low confidence levels, and now geopolitical risks in Ukraine have hampered the recovery. When you consider the financial state of Europe less than two years ago, you have to give the ECB, and Europe in general, some credit. Things are slowly heading in the right direction.

The views expressed are those of Brinker Capital and are for informational purposes only. Holdings are subject to change.

The full quarter returns masked the volatility risk assets experienced during the first three months of the year. Markets were able to shrug off geopolitical risks stemming from Russia and the Ukraine, fears of slowing economic growth in the U.S. and China, and a transition in Federal Reserve leadership. In a reversal of what we experienced in 2013, fixed income, commodities and REITs led global equities.

The U.S. equity market recovered from the mild drawdown in January to end the quarter with a modest gain. S&P sector performance was all over the map, with utilities (+10.1%) and healthcare (+5.8%) outperforming and consumer discretionary (-2.9%) and industrials (+0.1%) lagging. U.S. equity market leadership shifted in March. The higher growth-momentum stocks that were top performers in 2013, particularly biotech and internet companies, sold off meaningfully while value-oriented and dividend-paying companies posted gains. Leadership by market capitalization also shifted as small caps fell behind large caps.

International developed equities lagged the U.S. markets for the quarter; however, emerging market equities were also the beneficiary of a shift in investor sentiment in March. The asset class gained more than 5% in the final week to end the quarter relatively flat (-0.4%). Performance has been very mixed, with a strong rebound in Latin America, but with Russia and China still weak. This variation in performance and fundamentals argues for active management in the asset class. Valuations in emerging markets have become more attractive relative to developed markets, but risks remain which call into question the sustainability of the rally.

After posting a negative return in 2013, fixed income rallied in the first quarter. The yield on the 10-year U.S. Treasury note fell 35 basis points to end the quarter at 2.69% as fears of higher growth and inflation did not materialize. After the initial decline from the 3% level in January, the 10-year note spent the remainder of the quarter within a tight range. All fixed income sectors were positive for the quarter, with credit leading. Both investment-grade and high-yield credit spreads continued to grind tighter throughout the quarter. Within the U.S. credit sector, fundamentals are solid and the supply/demand dynamic is favorable, but valuations are elevated, especially in the investment grade space. We favor an actively managed best ideas strategy in high yield today, rather than broad market exposure.

While we believe that the long-term bias is for interest rates to move higher, the move will be protracted. Fixed income still plays an important role in portfolios as protection against equity market volatility. Our fixed income positioning in portfolios—which includes an emphasis on yield-advantaged, shorter-duration and low-volatility absolute return strategies—is designed to successfully navigate a rising or stable interest rate environment.

We approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we begin the second quarter, with a number of factors supporting the economy and markets over the intermediate term.

Global monetary policy remains accommodative: Even with the Fed tapering asset purchases, short-term interest rates should remain near zero until 2015. In addition, the ECB stands ready to provide support if necessary, and the Bank of Japan continues its aggressive monetary easing program.

Global growth stable: U.S. economic growth has been slow and steady. While the weather appears to have had a negative impact on growth during the first quarter, we still see pent-up demand in cyclical sectors like housing and capital goods. Outside of the U.S. growth has not been very robust, but it is still positive.

Labor market progress: The recovery in the labor market has been slow, but we have continued to add jobs. The unemployment rate has fallen to 6.7%.

Inflation tame: With the CPI increasing just +1.1% over the last 12 months and core CPI running at +1.6%, inflation is below the Fed’s 2% target. Inflation expectations are also tame, providing the Fed flexibility to remain accommodative.

U.S. companies remain in solid shape: U.S. companies have solid balance sheets with cash that could be reinvested, used for acquisitions, or returned to shareholders. Corporate profits remain at high levels, and margins have been resilient.

Less drag from Washington: After serving as a major uncertainty over the last few years, there has been some movement in Washington. Fiscal drag will not have a major impact on growth this year. Congress agreed to both a budget and the extension of the debt ceiling. The deficit has also shown improvement in the short term.

Equity fund flows turned positive: Continued inflows would provide further support to the equity markets.

However, risks facing the economy and markets remain, including:

Fed tapering/tightening: If the Fed continues at its current pace, quantitative easing should end in the fourth quarter. Historically, risk assets have reacted negatively when monetary stimulus has been withdrawn; however, this withdrawal is more gradual, and the economy appears to be on more solid footing this time. Should economic growth and inflation pick up, market participants may become more concerned about the timing of the Fed’s first interest rate hike.

Significantly higher interest rates: Rates moving significantly higher from current levels could stifle the economic recovery. Should mortgage rates move higher, it could jeopardize the recovery in the housing market.

Emerging markets: Slower growth and capital outflows could continue to weigh on emerging markets. While growth in China is slowing, there is not yet evidence of a hard landing.

Geopolitical Risks: The events surrounding Russia and Ukraine are further evidence that geopolitical risks cannot be ignored.

Risk assets should continue to perform if real growth continues to recover; however, we could see volatility as markets digest the continued withdrawal of stimulus by the Federal Reserve. Economic data will be watched closely for signs that could lead to tighter monetary policy earlier than expected. Valuations have certainly moved higher, but are not overly rich relative to history, and may even be reasonable when considering the level of interest rates and inflation. Credit conditions still provide a positive backdrop for the markets.

Source: Brinker Capital

Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high-conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Data points above compiled from FactSet, Standard & Poor’s, MSCI, and Barclays. The views expressed are those of Brinker Capital and are for informational purposes only. Holdings subject to change.

The U.S. equity market suffered a mild pullback in the second half of January, but resumed its trend higher in early February. The S&P 500 Index gained 4.3% in February to close at a record-high level. The consumer discretionary (+6.2%) and healthcare (+6.2%) sectors led during the month, while telecom (-1.8%) and financials (+3.1%) lagged. From a style perspective, growth continues to lead value across all market caps.

International equity markets edged out U.S. markets in February, helped by a weaker U.S. dollar. Performance on the developed side was mixed. Japan suffered a decline for the month (-0.5%), but Europe posted solid gains (+7.3%). Emerging markets bounced back (+3.3%) as taper fears eased somewhat; however, they remain negative for the year.

Interest rates were unchanged in February and all fixed income sectors posted small gains. The 10-year Treasury ended the month at 2.66%, 34 basis points lower than where it started the year. Credit, both investment grade and high yield, continues to perform very well as spreads grind lower. High yield gained over 2% for the month. Municipal bonds have started the year off very strong gaining more than 3% despite concerns over Puerto Rico. Flows to the asset class have turned positive again, and fundamentals continue to improve.

While we believe that the bias is for interest rates to move higher, it will likely be a choppy ride. Despite an expectation of rising rates, fixed income still plays an important role in portfolios as a hedge to equity-oriented assets, just as we saw in January. Our fixed income positioning in portfolios—which includes an emphasis on yield-advantaged, shorter duration and low volatility absolute return strategies—is designed to successfully navigate a rising or stable interest rate environment.

We approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we move into 2014, with a number of factors supporting the economy and markets over the intermediate term.

Monetary policy remains accommodative: Even with the Fed tapering asset purchases, short-term interest rates should remain near zero until 2015. Federal Reserve Chair Yellen wants to see evidence of stronger growth. In addition, the European Central Bank stands ready to provide support, and the Bank of Japan has embraced an aggressive monetary easing program.

Global growth stable: U.S. economic growth has been slow and steady. While momentum picked up in the second half of 2013, the weather appears to have had a negative impact on growth to start 2014. Outside of the U.S. growth has not been very robust, but it is still positive.

Labor market progress: The recovery in the labor market has been slow, but stable. The unemployment rate has fallen to 6.6%.

Inflation tame: With the CPI increasing just +1.6% over the last 12 months, inflation in the U.S. is running below the Fed’s target.

U.S. companies remain in solid shape: U.S. companies have solid balance sheets that could be reinvested, returned to shareholders, or used for acquisitions. Corporate profits remain at high levels, and margins have been resilient.

Equity fund flows turned positive: Continued inflows would provide further support to the equity markets.

Some movement on fiscal policy: After serving as a major uncertainty over the last few years, there has been some movement in Washington. Fiscal drag will not have a major impact on growth this year. All parties in Washington were able to agree on a two-year budget agreement, averting another government shutdown, and the debt ceiling was addressed.

However, risks facing the economy and markets remain, including:

Fed tapering/exit: The Fed began reducing the amount of their asset purchases in January, and should they continue with an additional $10 billion at each meeting, quantitative easing should end in the fall. Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, the economy appears to be on more solid footing this time, and the withdrawal is more gradual. The reaction of emerging markets to Fed tapering is cause for concern and will contribute to higher market volatility.

Significantly higher interest rates: Rates moving significantly higher from current levels could stifle the economic recovery. Should mortgage rates move higher, it could jeopardize the recovery in the housing market.

Risk assets should continue to perform if real growth continues to recover; however, we could see volatility as markets digest the slow withdrawal of stimulus by the Federal Reserve. Valuations have certainly moved higher but are not overly rich relative to history. There are even pockets of attractive valuations, such as certain emerging markets. After the near 6% pullback in late January/early February, investor sentiment is now elevated again.

Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high-conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Data points above compiled from FactSet, Standard & Poor’s, MSCI, and Barclays. The views expressed are those of Brinker Capital and are for informational purposes only. Holdings subject to change.

After such a strong move higher in 2013, U.S. equity markets took a breather in January as the S&P 500 Index fell -3.5%. Volatility returned to the markets as concerns over the impact of Fed tapering and emerging economies weighed on investors. Investor sentiment, a contrarian indicator, had also climbed to extreme optimism levels, leaving the equity markets ripe for a short-term pullback.

In U.S. equity markets, the utilities (+3%) and healthcare (+1%) sectors delivered gains, while energy and consumer discretionary each declined -6%. Mid caps led both small and large caps in January, helped by the strong performance of REITs. Fourth quarter 2013 earnings season has been decent so far. Of the one-third of S&P 500 companies reporting, 73% have beat expectations.

U.S. equity markets led international markets in January, helped by a stronger currency. Performance within developed markets was mixed, with peripheral Europe outperforming (Ireland, Italy, Spain, Portugal), while Australia, France and Germany lagged.

Emerging markets equities significantly lagged developed markets in January, as the impact of Fed tapering, slower economic growth and higher inflation weighed on their economies. Countries with large current account deficits have seen their currencies weaken significantly. Latin America saw significant declines, with Argentina down -24%, Chile down -12% and Brazil down -11%. Asia fared slightly better, with the region down less than -5%. Emerging Europe was dragged lower with double-digit losses in Turkey.

Fixed income had a solid month of performance as interest rates fell across the yield curve. The 10-year Treasury note is now trading around 2.6%, 40 basis points lower than where it started the year. The Barclays Aggregate Index gained +1.5% in January, its best monthly return since July 2011. All major sectors were in positive territory for the month; however, higher-quality corporates led high yield. Municipal bonds edged out taxable bonds and continue to benefit from improving fundamentals.

We believe that the bias is for interest rates to move higher, but it will likely be choppy. Rising longer-term interest rates in the context of stronger economic growth and low inflation is a satisfactory outcome. Despite rising rates, fixed income still plays a role in portfolios, as a hedge to equity-oriented assets if we see weaker economic growth or major macro risks as experienced in January. Our fixed income positioning in portfolios, which includes an emphasis on yield advantaged, shorter duration and low volatility absolute return strategies, is designed to successfully navigate a rising or stable interest rate environment.

We continue to approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we move into 2014, with a number of factors supporting the economy and markets over the intermediate term.

Monetary policy remains accommodative: Even with the Fed beginning to taper asset purchases, short-term interest rates should remain near zero until 2015. In addition, the ECB stands ready to provide support, and the Bank of Japan has embraced an aggressive monetary easing program in an attempt to boost growth and inflation.

Global growth strengthening: U.S. economic growth has been slow and steady, but momentum picked up in the second half of 2013. Outside of the U.S., growth has not been very robust, but it is still positive.

Labor market progress: The recovery in the labor market has been slow, but stable. Monthly payroll gains have averaged more than 200,000, and the unemployment rate has fallen to 7%.

Inflation tame: With the CPI increasing +1.5% over the last 12 months, inflation in the U.S. is running below the Fed’s target.

Increase in Household Net Worth: Household net worth rose to a new high in the third quarter, helped by both financial and real estate assets. Rising net worth is a positive for consumer confidence and future consumption.

U.S. companies remain in solid shape: U.S. companies have solid balance sheets with cash that could be reinvested, returned to shareholders, or used for acquisitions. Corporate profits remain at high levels and margins have been resilient.

Equity fund flows turned positive: Equity mutual funds have experienced inflows over the last three months while fixed income funds have experienced significant outflows, a reversal of the pattern of the last five years. Continued inflows would provide further support to the equity markets.

Some movement on fiscal policy: After serving as a major uncertainty over the last few years, there seems to be some movement in Washington. Fiscal drag will not have a major impact on growth next year. All parties in Washington were able to agree on a two-year budget agreement, averting another government shutdown. However, the debt ceiling still needs to be addressed.

However, risks facing the economy and markets remain, including:

Fed Tapering: The Fed will begin reducing the amount of their asset purchases in January, and if they taper an additional $10 billion at each meeting, QE should end in the fall. Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, the economy appears to be on more solid footing this time and the withdrawal is more gradual. The reaction of emerging markets to Fed tapering is cause for concern and will contribute to higher market volatility.

Significantly higher interest rates: Rates moving significantly higher from current levels could stifle the economic recovery. Should mortgage rates move higher, it could jeopardize the recovery in the housing market.

Risk assets should continue to perform if real growth continues to recover; however, we could see volatility as markets digest the slow withdrawal of stimulus by the Federal Reserve. Valuations have certainly moved higher, but are not overly rich relative to history. There are even pockets of attractive valuations, such as emerging markets. We are not surprised that we have experienced a pull-back in equity markets to start the year as investor sentiment was elevated and it had been an extended period of time since we last experienced a correction. However, we expect it to be more short-term in nature and maintain a positive view on equities for the year.

We feel that our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high-conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Throughout this year, we have been in the camp that profit margins would not mean-revert. Better measures of labor and manufacturing productivity, technology improvements and cheaper imports have all helped profits. As the chart below shows, that was the case in the third quarter. In 2014, we expect margins to remain persistently high.

The big three—productivity, technology and cheap imports—should help again next year. Plus, we do not see excesses in business investment, inventory or debt (personal or commercial) in 2014.

Persistently high profit margins should help equities in 2014.

Source: International Strategy & Investment (ISI) Group LLC

The views expressed above are those of Brinker Capital and are not intended as investment advice.

U.S. equities continued to climb higher in November, with major indexes gaining between 2% and 4% for the month. Year to date through November, the S&P 500 Index has posted an impressive gain of 29.1%, while the small cap Russell 2000 Index has fared even better with a return of 36.1%. The last five years have proved to be a very good time to be invested in equity markets, with a cumulative return of 125% for the S&P 500 Index.

International developed equity markets posted small gains in November, and have failed to keep up with U.S. equity markets this year. In Japan, Prime Minister Abe’s policies have spurred risk taking, but the currency has also weakened. The European equity markets have benefited from economies and a financial system that are on the mend. Emerging markets continued to struggle in November and are negative year to date. Concerns over the impact of Fed tapering on emerging economies, as well as slower economic growth, have weighed on the asset class this year.

Interest rates have remained range-bound after the spike in the summer in response to Bernanke’s initial talk of tapering. The 10-year Treasury ended November at a level of 2.75%, just 10 basis points higher than where it began the month. Fixed income is still negative for the year-to-date period; the Barclays Aggregate was down -1.5% through November. However, high-yield credit has had a solid year so far, gaining close to 7%. We believe that the bias is for interest rates to move higher, but it will likely come in fits and starts.

The Fed will again face the decision to taper asset purchases at their December meeting, and we expect volatility in risk assets and interest rates surrounding this decision, just as we experienced in the second quarter. The recent economic data has surprised to the upside; however, inflation remains below the Fed’s target level. Despite their decision to reduce or end asset purchases, the Fed has signaled short-term rates will be on hold for some time. Rising longer-term interest rates in the context of stronger economic growth and low inflation is a satisfactory outcome.

We continue to approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we move into 2014, with a number of factors supporting the economy and markets.

Monetary policy remains accommodative: The Fed remains accommodative (even with the eventual end of asset purchases, short-term interest rates will remain near-zero until 2015), the European Central Bank has provided additional support through a rate cut, and the Bank of Japan has embraced an aggressive monetary easing program in an attempt to boost growth and inflation.

Global growth strengthening: U.S. economic growth has been steady and recently showing signs of picking up. The manufacturing and service PMIs remain solidly in expansion territory. Outside of the U.S., growth has not been very robust, but it is positive.

Labor market progress: The recovery in the labor market has been slow, but stable. Monthly payroll gains have averaged more than 200,000 and the unemployment rate has declined.

Inflation tame: With the CPI increasing only +1% over the last 12 months, inflation in the U.S. has been running below the Fed’s target level.

Increase in household net worth: Household net worth rose to a new high in the third quarter, helped by both financial and real estate assets. Rising net worth is a positive for consumer confidence and future consumption.

U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash that could be reinvested or returned to shareholders. Corporate profits remain at high levels and margins have been resilient.

Equity fund flows turn positive: Equity mutual funds have experienced inflows over the last two months while fixed income funds have experienced significant outflows, a reversal of the patter of the last five years. Continued inflows would provide further support to the equity markets.

Some Movement on Fiscal Policy: After serving as a major uncertainty over the last few years, there seems to be some movement in Washington. Fiscal drag will not have a major impact on growth next year. It looks like Congress may sign a two-year budget agreement, averting another government shutdown in January. However, the debt ceiling still needs to be addressed.

However, risks facing the economy and markets remain, including:

Fed Tapering: The markets are anxiously awaiting the Fed’s decision on tapering asset purchases, prompting further volatility in asset prices and interest rates. Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, the economy appears to be on more solid footing.

Significantly higher interest rates: Rates moving significantly higher from current levels could stifle the economic recovery. Should mortgage rates move higher, it could jeopardize the recovery in the housing market.

Sentiment elevated:Investor sentiment is elevated, which typically serves as a contrarian signal. The market has not experienced a correction in some time.

Risk assets should continue to perform if real growth continues to recover even in a higher interest rate environment; however, we expect continued volatility in the near term as we await the Fed’s decision on the fate of quantitative easing. Despite the strong run, valuations for large cap U.S. equities still look reasonable on a historical basis by a number of measures. Valuations in international developed markets look relatively attractive as well, while emerging markets are more mixed. Momentum remains strong; the S&P 500 Index has spent the entire year above its 200-day moving average. However, investor sentiment is elevated, which could provide ammunition for a short-term pull-back surrounding the Fed’s tapering decision.

Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high-conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Housing is a major component of the U.S. economy and the largest source of wealth for many Americans. Despite the recent rebound, home prices in the U.S. have declined a cumulative -16% since 2006. That masks significant declines in Sunbelt markets hit by the housing bubble collapse (FL -37%, AZ -32%, CA -26%, NV -45%).(Freddie Mac. September 2013)

Roughly 50% of the stock of housing in the U.S. is financed by mortgage debt. Consequently, the availability and cost of mortgage debt has a direct relationship on the value of housing. Indeed, the 2008 financial crisis exacerbated the downturn in housing as the financial system had sharply cut mortgage credit. The downturn in home prices also damaged consumer confidence for the two-thirds of Americans who owned their home. Many homeowners saw their savings reduced and consequently cut back on their consumption. Additionally, the housing downturn left nearly one out of five Americans underwater on their mortgage debt, (i.e. the resale value of their home in the current market would be less than the mortgage debt they owed). This resulted in higher credit losses for banks, which in turn reduced credit availability across the board.

One reason for sub-par economic growth following the 2008 financial crisis stems from the sub-par recovery in housing. Housing accounts for one out of every six dollars of economic output. (National Association of Home Builders)

Additionally, the housing downturn has impacted the job market. Approximately 2.5 million lost jobs between 2006 and 2013 were lost because of the housing downturn. Residential construction accounts for 1.5 million jobs including the financial sector and real estate. Housing-related employment amounts to as many as one out of every twelve jobs in the U.S. economy. (Bureau of Labor Statistics. September 6 and The Bipartisan Policy Center)

The issue of how to finance the largest asset for many Americans is of critical importance to future growth prospects for the U.S. economy.

Myth #1: America is a nation of part-timers
Here is what is true: Over the last four months, part-time employment has expanded by 8.9% at an annual rate while full-time employment has risen at just a 0.5% annual rate. What is not true is that rising part-time work represents a new structural phenomenon in the U.S. labor market.

Consider the following points: part-time employment represents one-fifth of total household employment. A quick inspection of this series screams cyclical NOT structural. That is, the series rises during recessions and falls as the recovery gains traction. The Household Survey is notoriously volatile, so it makes sense to analyze longer-term trends. Over the last year, all of the increase in part-time employment has been for non-economic reasons (child care, vacation, schooling, training, etc.)

Why has this subject generated so much attention? Simple. The Affordable Care Act (ACA). However, there is little survey evidence that firms plan to materially alter worker hours because of the health law. A survey of firms across the New York Fed District found that only 12% of respondents refrained from hiring or shifted full-time workers into part-time; that compares to 7% that made minimal changes to their workforce. So, the ACA is having marginal impact, but it is overwhelmed by business cycle dynamics.

Myth #2: Job gains are all low wage
Earlier this month USA Today ran with the following headline, “Many new jobs are part-time and low-paying”. This is a true statement. Many of the jobs being created are low-paying and that may or may not be something to worry about. What is not true, however, is that this is a new development and unique only to this recovery.

The two sectors that get the most attention are retail trade and leisure & hospitality. So, we went back five economic cycles and looked at the composition of employment growth from the payroll trough to peak. Here is what we found: retail trade and leisure & hospitality employment, typically accounts for one-fourth of the job creation. In this cycle, 28.2% of the new jobs are in these categories. That compares to 28.4% in the 2003-07 recover, 23.4% in the 90s, 28.5% in the 80s, and 23.7% in the 70s.

More broadly, the narrative misses the fact the wages typically lag in employment recoveries. While the labor market continues to recover in a relative sense, there is still plenty of slack. What is important is that these unemployed workers here value. Otherwise, they would not be able to exert downward pressure on the wages of those working and the newly employed. That tells us the labor stack is cyclical not structural. As the labor recovery ensues and the slack is absorbed, wages will begin to rise. When growth bears fret about low-wage work, a more apt translation at this stage is: it is still early in the jobs recovery.

The views expressed above are those of Neil Dutta and are not intended as investment advice.

Concern lurched back into the market place last week, as the specter of an eventual withdrawal of the extraordinary measures the U.S. Central Bank has employed since the financial crisis, served to temporarily rattle markets around the globe. Although stocks rebounded smartly as the week drew to a close, from what had been the largest two-day selloff seen since November, the increase in volatility is noteworthy as it spread quickly across asset classes, highlighting the uncertainty that lingers below the surface.

Equities listed in the United States retreated from the five-year highs they had reached early last week following the release of the minutes of the most recent Federal Open Market Committee (FOMC) meeting as the voices of those expressing reservations about continuing the unprecedented efforts of the Central Bank to stimulate the U.S. economy grew louder. The concern of these members of the Committee stems from a fear that the current accommodative monetary policy may lead to “asset bubbles” (Bloomberg News) that would serve to undermine these programs. “A number of participants stated that an ongoing evaluation of the efficacy, costs and risks of asset purchases might well lead the committee to taper, or end, its purchases before it judged that a substantial improvement in the outlook for the labor market had occurred. The minutes stated.” (Wall Street Journal).

Tangible evidence of the unease these words created in the marketplace could be found in the Chicago Board Options Exchange Volatility Index, or VIX, which measures expected market volatility, as it leapt 19% in the aftermath of this statement representing its largest single-day gain since November 2011 (Bloomberg News). The reaction of investors to the mere possibility of the Fed pulling back its historic efforts illustrates the continued dependence of the marketplace on this intervention and highlights the difficulties facing the Central Bank in not derailing the current rally in equities when it eventually pares back its involvement.

A measure of the uncertainty surrounding the timing of the Federal Reserve’s withdrawal of its unprecedented efforts to support the U.S. economy was dispelled by St. Louis Fed President, James Bullard, in an interview he gave late last week. Mr. Bullard, currently a voting member of the FOMC, was quoted by CNBC, “I think policy is much easier than it was last year because the outright purchases are a more potent tool than the ‘Twist’ program was…Fed policy is very easy and is going to stay easy for a long time.”

Reports of statements made by The Chairman of the Federal Reserve, Ben Bernanke, earlier this month, which downplayed the potential creation of dangerous asset bubbles through the Central Bank’s actions, released Friday, helped to further assuage the market’s concerns. “The Fed Chairman brushed off the risks of asset bubbles in response to a presentation on the subject…Among the concerns raised, according to this person, were rising farmland prices, and the growth of mortgage real estate investment trusts. Falling yields on speculative-grade bonds also were mentioned as a potential concern” (Bloomberg News). Although the rhetoric offered by these members of the Federal Reserve in the wake of the release of the minutes of the FOMC was offered to alleviate fears, the text of the meeting has served as a reminder to the marketplace that the asset purchases currently underway, which total $85 billion per month, will be reduced at some point in the future, and as such, has served as a de facto tightening of policy.

Though investors appeared to be appeased by the words of Mr. Bullard as well as those of Mr. Bernanke, the steep selloff that accompanied the mention of a pull back of the Central Bank’s efforts is a reminder of the high-wire act the Fed is facing when it does in fact need to extricate itself from the bond market.

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Brinker Capital provides this communication as a matter of general information. Portfolio managers at Brinker Capital make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.